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Understanding ‘Closing The Books’

Understanding ‘Closing the Books’

What is “Closing the Books”?

In accounting, the word “books” refers a company’s record of financial transactions. The term “closing the books” refers to an accounting procedure that happens at the end of each month or designated company period, and at the end of each year.

The Procedure

Financial transactions today are typically recorded in accounting software, but years ago they were recorded in accounting books. The “closing the books” procedure helps ensure that the data entered into the accounting records are accurate so financial reports can be created and finalized. The reports alert management as to how much money is flowing in and out of the business. Management will use the financial reports to analyze financial aspects of the business and will decide how to improve it, while stakeholders will refer to the reports to assess how well the business is performing.

The process of closing the books has three steps.

  1. Financial data is entered into the books or recording system.  
  2. Data that has been entered into the system is reconciled, meaning it’s double-checked to ensure it’s accurate.
  3. Company accountants “close the books,” meaning they approve and finalize the data so financial reports like the income statement and balance sheet can be created.

Recording Data

Designated employees across business units record into a record-keeping system financial transactions. Transaction records consist of amounts presented as debits or credits, the transaction date, a description of the transaction, and often contain a unique reference number. This information may be recorded into a general journal or a specific transaction journal, which might be for sales of products or services, sales of assets, special purchases, or for depreciation. By the end of the accounting period, usually monthly, all the journal entries will be entered into the main accounting book: the general ledger (GL).

The GL provides a record of financial transactions and data that has taken place over the life of the company and tracks all accounts: liabilities, assets, equity, revenues, and expenses. After data has been entered into the company accounting system, it must be reconciled.

Reconciling Data

Reconciling data is an accounting procedure in which transaction records are compared to bank statements and other records to ensure that the amounts entered into the accounting system are correct. In addition to reconciliation for banking, there is reconciliation for financial transactions with customers and vendors, and inter-company and business transactions. When the supporting documentation doesn’t match the data that has been recorded into the GL, there is a discrepancy. An accountant then must conduct research to discover the error and fix it to ensure the GL accurately reflects the financial activity.

Approving and Closing the Books

After the data has been reconciled, the data will be shared with the company’s main accountant or controller for final approval. The controller then closes and “locks the books,” which means no one else can touch the financial data in the time period that has just closed. If months or years later someone discovers an error or omission that was made at some point in the past, an accountant will usually apply the correction to the current month in which the error was discovered. This type of correction is called a true-up entry, sometimes referred to as a catch-up entry.

History of Closing the Books

The term “books” harkens back to a time when a book of account activity was maintained. Each account was tracked on ledger paper, which had columns for the transaction date, description, and dollar amount. The ledger paper was then combined into a book of accounts. There are five general categories of accounts:

  1. Assets (cash, inventory, accounts receivable, owned real estate and equipment)
  2. Liabilities (accounts payable, notes payable, accruals)
  3. Equity (owners’ contributions, retained earnings)
  4. Income (revenue or sales generated by the business)
  5. Expenses (amounts paid to run the business)

Each of these categories may have had its own book of ledgers or journals, or the five accounts could have been combined into one book. At the end of each month, or financial period, an accountant would total up all the activity and often drew a line at the end to signify that period was “closed.” Once a period was closed, no more entries could be entered into the book for that period. A new period would be created in the book for future transactions.

This accounting process begat the phrase “closing the books.” Since the accounting department conducted business using actual financial books, it became known as the “bookkeeping department.”

Although few companies still use accounting materials like paper and books to keep track of financial transactions since software is far easier and more efficient, accountants still use words like “books,” “ledgers” and “journals.”